By: Michael Allbee, CFP®, Senior Portfolio Manager
Volatility or down markets only become a problem if you’re forced to liquidate at the wrong time. If you have enough cash to get you through, you’re going to come out fine on the other side most of the time. We generally recommend setting aside funds to cover 3-6 months’ (6-12 months’ if retired) worth of non-discretionary living expenses (i.e., housing, taxes, debt service, groceries referred to as needs) as an emergency reserve. This recommendation helps our clients handle short-term problems that are beyond their control (i.e., unemployment, car problems, medical bills, etc.). Without an emergency fund most people resort to using high-interest rate credit cards to pay their expenses. This conflicts with your long-term goal of saving for retirement and/or portfolio withdrawals at an inopportune time.
We also recommend matching the time horizon for when you may need the money with the chosen savings product. For example, we recommend keeping some of your emergency reserve in a FDIC-insured savings account at your bank, an online bank, or credit union that offer daily liquidity. What you earn on your emergency reserve is irrelevant and the main goal of this investment is liquidity. However, one positive of the current increase in yields, is that many of these FDIC-insured savings accounts now offer yields up to 0.90% today. Recently, we have been working with clients to purchase 3-month to 2-year Treasury bills yielding between 1.7% – 3.2% for a portion of their emergency reserves or for other short- and medium-term savings goals, such as a down payment for a house or car purchase. These yields are higher than current Certificate of Deposit (CD) rates and are principal protected if held to maturity.
If you have excess reserves that you won’t need for at least 12-months (and preferably 5 years), we have been recommending Series I savings bonds (I Bonds). I Bonds are currently yielding 9.62% and can be bought directly from the Treasury Direct website. Unfortunately, each person is limited to purchasing $10,000 worth of I Bonds a year, and the yields will fluctuate based on inflation. Furthermore, if you cash in your I Bonds within five years of purchasing them, you lose the previous 3 months of interest.
Another consideration is a Roth IRA. The Roth is unique, in that any contributions you make to a Roth can be withdrawn without penalty or taxes. The caveat is that any earnings in the account need to remain for five years, and you must be 59.5 years old or older (unless an exception applies) for it to be considered a qualified distribution to avoid taxes and a 10% penalty. In turn, you are technically saving for retirement and building a nest egg for any short-term unexpected expenses. This option should be looked at as an additional cushion to your emergency reserve and not as a replacement, since the funds in your Roth account should be invested in the markets which will fluctuate in value.
We highly encourage you to Talk With Us if you want to strategize about your emergency reserves or need help building your emergency fund.
Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.
At the end of 2019, no one predicted that the unemployment rate would hit its highest level since the Great Depression, average wages would decline but household incomes would increase, thanks to government stimulus checks. Had the U.S. government not provided stimulus checks, many more Americans would have struggled financially.
Financial advisors typically recommend having at least 3–6 months of non-discretionary living expenses (i.e., housing, taxes, debt service, groceries referred to as needs). This recommendation helps people handle short-term problems like being out of work for a month or two allowing them to pay their bills and not take on debt. Unfortunately, not everyone had an emergency fund for unexpected expenses, and individuals, depending on their income were impacted very differently.
Looking at the above chart we see that people have been put into one of six buckets based on their income. Those with the highest income (the 90–100 group) showed the most resilience and on average have about 10.7 months’ worth of expenses saved up. That suggests the average person in this group would have been fine and could have lived off savings since the pandemic began. Looking at the other two highest groups (60-79.9 & 80-89.9) have at least the minimum savings typically recommended by financial advisors of three to six months. However, the lower-wage earners are not so lucky and have anywhere from two weeks (less than 20) to 1.6 months in savings (40-59.9).
Due to the economic impact of the pandemic, many individuals hit the hardest were in the lower half of the income earners. This is unfortunate since they have the smallest emergency funds and have been forced to make tough financial decisions like taking on debt or making withdrawals from retirement accounts.
The pandemic has impacted individuals very differently and we are learning about the financial devastation of handling a long-term problem. The stark reminder though is the importance to build and maintain an emergency fund to help when things happen beyond our control. This of course assumes your financial situation allows you to. If you or anyone you know is working to build or rebuild their emergency fund, we are happy to talk and provide some free resources.
Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.